The (Mis)selling of Investments 😕

Long time back in 2007, I was interning at the private banking division of a globally reputed bank. I was assisting “Relationship Managers” (RMs), who in turn “helped” their clients invest - primarily in mutual funds and insurance policies.

I’d see clients who would come in & hand over a cheque with a stated amount (usually in many lakhs) but where the payee name was blank - the clients would simply trust the RM to put their money where they thought it would be best for them, i.e. the client.

And then at the end of the day, the RMs would ask me to find out which funds currently provided the highest commission, and simply ask me to fill the cheque with the name of that mutual fund.

It didn’t matter as much whether the investment met the goals of the client - what mattered more was how much it helped them meet their objectives.

After all, they had their own targets & incentives which, in turn, primarily determined their actions and recommendations.

This problem mainly arose because the incentives of the professional advising - the RMs, in this case - didn’t align with the goals and objectives of the client. This is one of the classic examples of what is known as the principle-agent problem.

Now, let me re-emphasise that this has just been my experience - and since then, I’ve met many other private bankers who genuinely care about their clients. But as a general rule, I feel the (mis)selling of products has been a large issue with the investments industry.

Which is why, over time SEBI set up clear guidelines in order to streamline this. Today, things are far more transparent and more rules are in place in order to prevent this.

Some time back, SEBI even proposed to make the distinction between mutual fund “distributors” and “advisors” clearer. In short, distributors are people/institutions (including RMs at most banks) that sell mutual funds, but they cannot really advise a client.

Most importantly, they do not have a fiduciary duty to act in the best interests of the client. Since they are in the business of selling and not advising, they can operate like that.

After all, distributors earn their money via commissions from mutual fund sales, and not from you, the client.

On the other hand, SEBI registered advisors have a fiduciary duty to act in the best interests of the client. They are mandated by law to earn their money from their clients, and not from commissions.

As such, they don’t really have any incentive to recommend you a fund that is not in your best interests, since they will not be making any money from commissions via selling you a particular fund or investment product.

SEBI registered advisors are becoming increasingly popular, with increasing transparency and scrutiny coming in the financial space. Usually, they tend to charge a flat fee for their consultation and investment solutions, which in my opinion, reduces a lot of the principal-agent problem.

But while SEBI is doing its bit to promote investor protection, the ultimate defense for any investor are they themselves. From my experience, I’ve learnt the importance of asking questions - especially when it comes to being sold any product.

So next time when you are being sold an investment idea, question what’s in it for them. It will hopefully give you a clearer picture of why something is being recommended or pitched to you. And help you better decide whether it helps you with your objectives.